Effects and influences of the opening up to the buy side of EBS and Reuters. Marshall Bailey Presentation to the ECB FXCG Meeting September 7 th 2006

Transcription

1 Effects and influences of the opening up to the buy side Marshall Bailey Presentation to the ECB FXCG Meeting September 7 th 2006

2 Effects and influences of the opening up to the buy side Table of Contents History of the FX market Current market structure Ai and PB Market Risks Profitability models Future 2

3 History of the FX market 3

4 The FX market 1876 to World War I the gold exchange standard ruled over the international economic system Under the gold exchange, currencies experienced a new era of stability because they were supported by the price of gold 1944 the Bretton Woods Agreement was founded in order to stabilize and regulate the international Forex market preventing money from moving across nations and restricting speculation in the world currencies 1980 s the onset of computers and technology accelerated the pace of extending the market continuum for cross-border capital movements through time zones. From Telex to telephone to computers. Transactions in foreign exchange increased intensively from nearly $70billion a day in the 1980s to an average of $1.86 trillion a day (Source: Bloomberg, July 2006) In London trading rose 19% to an average of $1.03 trillion a day U.S. currency trading increased 21% to an average of $577 billion a day Currency trading in Singapore rose 17% to an average $195.1 billion a day 4

5 Effects and influences of the opening up to the buy side FX: an over-the counter market Inter-dealer market FX electronic matching: BANK Inter-dealer market FX electronic matching: -EBS -Reuters Dealer-to-customer- market Portals Prime brokerage products Inter-dealer broker BANK Bank branch/ Regional bank -EBS -Reuters Dealer-to-customer- market FX Trading Portals -Single bank portals -Multi-bank portals Hedge Fund Other financial Corporate 5

6 The FX market (today) World s biggest and most actively traded asset class Market growing at 19% a year and the fastest growing sector is the buy-side Trading moving rapidly from voice to electronic Increase in high frequency trading 6

7 Cutting intermediaries: Interaction between participants prior to electronic trading Intermediates Brokers Dealers End-users: Individual traders Institutional investors Large corporations Dealers proprietary desks Source: BIS, January

8 Effects and influences of the opening up to the buy side Interaction between participants after the introduction of electronic trading Reduced importance of the direct trading channels and the traditional inter-dealer broker channels? Source: BIS, January

9 Current market structure 9

10 10

11 The Stock Exchange vs. an OTC market Stock Exchange is a centrally organized marketplace Stock markets across Europe are planning to group together: Bourse to merge with Brussels and Amsterdam stock exchange => Euronex Norway, Sweden and Denmark are pooling their exchanges London Stock Exchange and Deutsche Boerse => ix Plans to link up with New York s hi-tech exchange Nasdaq => could pave the way for a unified global stock exchange Equity markets are the best known and most widely studied examples of electronic trading Bond side can be traded on electronic platforms: Trade Web, Market Access, Bloomberg - BBT and AutoEX System, Reuters - MTFI platform The FX market (OTC) is living through continuous transitions but can a similar trend be seen as in the Stock Exchange? 11

12 Market Evolution: The market is driving towards a more open trading alternative Single - Bank Platforms Multi Bank Platforms IDB with Prime Brokerage IDB with Prime Brokerage and limited CCP *NEW* OPEN Buy & Sell-side Platform with CCP Bilateral customer relationship Client relationship / cross-market capability Attract additional order flow Effective liquidity management Manages market growth Consolidated market efficiencies Service hedge fund flows Support for algorithmic models Attract additional order flow Provide credit intermediation for the creditchallenged inter-bank market CCP = Centrally cleared counterparty Source: Reuters, May

13 Effects and influences of the opening up to the buy side Inter-dealer market Two strong platforms with complementary currency pair strength EBS and Reuters have become very impressive liquidity pools Number of transactions on both systems: steadily rising in recent years with little evidence of significant price-gapping Dealer-to-client market A fractured market with specialized platforms Targeting a specific type of customer within the buy-side Hotspot - serving hedge funds and CTA s FX Connect serving asset managers 360 Treasury System - dominated among European corporate treasurers LavaFX and espeed strength in equities trading Is there room for all the existing and new platforms in this market? How much does the market rely on the robustness of surrounding telecommunications infrastructure? 13

14 Electronic Volume Voice Volume 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Inter-Dealer 2004 Inter-Dealer 2007 Dealer-to-Client 2004 Dealer-to-Client 2007 Source: BIS, December

15 Buy-side More interested in trading on electronic FX platforms: Speed of execution Transparency Buy-side customers also are attracted to the electronic platforms by the lower transaction costs The audit trail is much easier to follow with electronic platforms Sell-side Interbank market is becoming more bifurcated Large banks contribute price discovery and liquidity to the electronic platforms Small banks act like buy-side customers in the dealer-client platforms => removing liquidity but only nominally providing it 15

16 Reuters 20 years experience in the FX and money markets 1996 launched Dealing 3000 Spot Matching, Forward Matching, Reuters Matching for FX Options 43 key currency pairs in spot and 28 currencies in forwards 19,000 users located in more than 6,000 organisations in 110 countries worldwide 112,000 users in Reuters Treasury community 18,000 Conversational Dealing users 7,000 Dealing Matching users Revenues of c. 1 billion in 2005 from Reuters Dealing and Treasury information services 16

17 EBS World s leading FX Spot broker major international banks agreed to challenge Reuters' threatened monopoly in interbank spot foreign exchange and provide effective competition September 1993 EBS Dealing System launched EBS alone averages some $90-$100bn a day and up to 700 trades a minute 2,000 traders on more than 800 dealing floors in + 40 countries EBS Spot, EBS Prime, EBS Spot Ai, EBS market data Average of trade per day of USD 130 billion in spot foreign exchange transactions 700,000 oz in gold and 7 million oz in silver 17

18 Ai and PB 18

19 Current situation of the Ai and PB systems: Prime Brokerage systems: Before the advent of hedge funds services include: Cash lending through margin services and repos, stock lending and foreign exchange transactions Now most prime brokers: EBS Prime Reuters Added more sophisticated services Individual profitability is a matter of speculation Application programme interface technology: EBS Spot Ai Reuters Matching-over-internet-protocol 19

20 Reuters Prime Broker 17% of Reuters volumes from trading 10% of the figure from the sell-side 90% of the figure from the buy-side MOIP (Matching-over-internet-protocol) FX Market Space Joint Venture: Reuters and CME Will be a direct competitor to Reuters and EBS Created its own independent pool of liquidity 20

21 FX MarketSpace Reuters value proposition Reduced cost of trading Reduced risk Centralised pool of deep liquidity Anonymous, multi-lateral matching STP and operational efficiency Strongly funded 21

22 Effects and influences of the opening up to the buy side The FX MarketSpace value Access via Reuters GUI or CME GLOBEX API Banks Clearing Prime Brokers Prop traders Clearing Prime Brokers Centrally cleared counterparty (CCP) -based matching Clearing house CLS bank Continuous Linked Settlement Leveraged Funds Clearing Prime Brokers Buyside / End User Prime Broker/Clearing Member GUI - Reuters integrated Fiduciary responsibility API trading support for Authorise access algorithmic trading Enforce access rules CCP no bi-lateral credit Post collateral with CCP required Limit & trade admin Aggregated liquidity STP allocations, etc. If Required, Comprehensive Insert Client STP Logo Here Source: Reuters, May 2006 Liquidity Providers Access to best pricing & aggregated liquidity Anonymous trading Access to flow No credit risk Operational cost savings Reduce e.trading costs Clearing House Multilateral netting Collateralised margining Net settlement Improvement of funds flow Facilitates increased trading Real-time deal confirmation CLS Settlement risk elimination Operational efficiencies 22

23 EBS Prime 149 users now live 37 non-bank customers including hedge funds 112 bank customers 23

24 EBS Prime: Benefits for the Customer Same liquidity available to EBS top tier bank See and trade on prices previously unavailable due to limited bilateral credit Access to tighter prices and greater depth of liquidity from the world s leading market making banks Continuous price stream of more competitive prices Increased probability of execution of orders (deal on your bid/offer) Maintain the relationship between banks and their clients 24

25 EBS Spot Ai API or black-box FX trading Average daily volumes USD 30 billion 20% of EBS volumes from API-based trading 25

26 Revenue Services such as cash lending through margin services and repos, stock lending and foreign exchange transactions remain the core profitable services to the banks Customers contract directly with EBS Prime banks => pay a fee to their EBS Prime bank (typically in the form of a spread added to the dealt price on the EBS Prime Customer s deal ticket) Customers pay a standard EBS Spot transaction brokerage fee to EBS 26

27 Prediction for the Prime Brokerage Units of Investment Banks in 2006 Rise in revenue for the PB Units of the major European and US Investment Banks Reasons for rise: Prime brokerage compete to offer additional services Prime brokerage services to hedge funds can be seen as the catalyst to capturing their transaction flow 27

28 Market Risk 28

29 Implications for the Market Replacing Basic Broking Services Lower transaction cost Perfect market conditions STP Split liquidity Greater competition Speed of execution Lower staffing costs Enhancing Operational Efficiency Concentration of Trading in Winner System Magnification of liquidity / or under priced systematically Transparency Blurring of Distinctions between Interdealer and dealerto-customer markets 29

30 Evaluating the market development Liquidity Will it be possible to trade in size on demand without moving the price against the price maker? Settlement risk How high will be the Herstatt risk? Systems/operations How to react to upcoming errors such as non-matching trade confirmation? Credit intermediation CLS Will the credit risk arise? Market-standard for FX settlement between major banks 04/2006: 300,000 instructions a day in 15currencies (98% of global FX trading) Average daily value exceeding US$2.5 trillion Will there be more exchange styles? 30

31 Profitability models 31

32 Source of revenue Proprietary trading Spread (for all products such as vanilla and exotic products, derivatives, etc.) Prime Broking fees Latency arbitrage What might be the future for the efx market? 32

33 Proprietary trading Banks making a profit for itself when trading its own money Majority of trading profits comes from bond and commodity Proprietary traders make big profits versus often equally high losses Spread Structured in two different ways ( cash versus volume ) Which one is more profitable? Will the transparency destroy the profitability? 33

34 Prime Broking fees Commission or fees charged for a transaction Brokerage fees can be structured in lots of different ways: A percentage of the contract value A flat fee A mixture of these two methods What would be the right commission / fee? 34

35 Latency arbitrage Delay of 0.1 sec cost money => need to be real time Latency reduces the competitiveness of the product Latency encourage clients to arbitrage among various price feeds Source: If Required, EBS, Insert 2004 Client Logo Here 35

36 Future 36

37 Discussion Is there a risk of creating a duopoly if EBS and Reuters are the source for e- pricing? Does cutting out intermediates equal the end of human trading? Is it appropriate for EBS and Reuters to further open up to the buy side? Other? 37

38 38

39 References CELENT: An More Money, More Platforms: Profiling the E-Trading Vendors in the Cash Forex Markets; Feb CELENT: An Overview of the Cash Foreign Exchange Markets; Feb Bank for International Settlement (BIS): The implications of electronic trading in financial markets; Jan BIS Report ; Dec 2004 EBS; 2006 Reuters;

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41 Effects and influences of the opening up to the buy side Marshall Bailey Presentation to the ECB FXCG Meeting September 7 th 2006